Comparing Spread Betting to Forex Trading

Example: Forex Trade Transaction

Foreign Exchange (Forex) trading is simply the exchanging of one currency for another - Each Forex trade can theoretically be viewed as a 'spread ' trade where to buy one currency you must sell another. Convention dictates that currencies are measured in units per 1 USD. For example, 1 USD is worth approximately 125 JPY (Japanese Yen) or 1 USD is worth approximately 1.5000 CHF (Swiss Francs). As a result, when USDJPY appreciates in value, it is the USD which has appreciated in value relative to the JPY and not vice-versa. Position-wise, to own or be 'Long' USDJPY means that you are long the USD and concurrently short the JPY. USD, therefore, is the default 'lead' currency.

It is open 24 hours a day (which a financial bookmaker may not be) - with buyers and sellers operating by telephone worldwide. Settlement is in two day, or sometimes less. The most popular trades are between the US dollar and either Sterling or the Euro. Your risk is that a currency bet could go the wrong way. To protect yourself, enter your trade with a target level and a stop loss.

Let's assume you have a trading account of $20,000 and you have chosen to use 100:1 leverage on your account. The current quote for EUR/USD is 1.3225/28. You place a market order to buy 1 lot of 100,000 Euros at 1.3228, expecting the euro to strengthen. At the same time you place a stop-loss order at 1.3203, and a limit order at 1.3328.

The value of this transaction is $132,280 (100,000 * 1.3228) but because you are using 100:1 leverage, you only need a margin deposit of 1% of the total, which is $1322.80 ($132,280 * 0.01).

The price rises to 1.3328/31, reaching your limit order at 1.3328, and your position is closed. You have made a profit of 100 pips.

Your total profit for this transaction is $1,000 (100,000 * (1.3328 - 1.3228)), and the return on your investment is 75.6% ($1000/$1322.80) .

Trade Summary

Opening Balance: $20,000
Buy:1 std lot EUR/USD @ 1.3228 = $132,280
Margin Requirement:$1322.80
Position Size:6.6% of the account ($1322.80/$20,000)
Pip Value:$10
Stop-Loss:25 pips (representing 1.25% of the account)
Limit:100 pips
Risk/Reward Ratio:4:1
Sell:1 std lot EUR/USD @ 1.3328 = $133,280
Return:75.6% ($1,000/$1322.80)
Closing Balance:$21,000 (+5% gain)

On the subject of forex trading, spread betting firms' spreads are very similar to retail forex brokers. That's right. The costs are the same. The difference is whether you get taxed on it which can really make a substantial difference. Makes the decision a no-brainer for anyone other than a consistent loser not troubled by annual profits.

With spread-betting, there are no "lots" as such. You just decide how much you want to "bet". So, for instance, if you look at EUR/USD the spread will be, say, 1.3320 - 1.3323. Let's say you think EUR/USD will fall, and you want to go short. You can sell at 1.3320 for £1 per pip or any multiple of £1 per pip. You have to "put up as margin" anything you want for your stop-loss plus some fixed margin amount (maybe 20 pips extra, or whatever) .

I prefer spread betting to traditional foreign exchange dealing, but that's just me. A lot of people lose money at spread-betting just as with any form of trading (but perhaps all the more so because the potential to "play with small margin" makes it even more dangerous for people who don't know what they're doing!). Few people care to admit to themselves that they don't know what they are doing. However, it's easy enough to get the feel for it. All you need to do is try out one or two of the spread betting firms in "demo mode" [try opening a demo account at Ayondo to practice]. The forex brokers tend to have better platforms but from a spread/ bias perspective, you have an equal opportunity to profit with a good sb company in comparison to a good forex broker.

Just ask yourself this: If the foreign exchange brokers charge a 3 pip spread and a spread betting firm charges exactly the same, what is the benefit of using an FX broker? As I have pointed out in the past, if the forex spread being offered by Deal4Free is the same as that being offered by CMC Plc (the same company), there is no incentive whatsoever to execute the trade through the latter. Assuming you make a profit of £100 from the trade, you would have to hand over £22 to £40 (depending on your circumstances) to the Inland Revenue just because you want to call yourself a 'trader' as opposed to a 'gambler'. Assuming that happens just 100 times a year, there is a difference of £2,200 to £4,000; not an amount to be sniffed at.

Personally, I have an account with which I don't use very much, and an account with Ayondo in London, which I use every day. Dealing in one 10,000 contract with fxcm is the same as doing a £1 per point spread-bet. To me, the differences are (i) that the spreads are typically smaller with Capital Spreads, (ii) the customer service is typically better and (iii) the profits are completely tax-free from "betting" but not from "investment". This last point is a peculiarity under UK tax law and probably not relevant to non-UK residents, though it's very relevant here, of course! A lot of people have out-of-date and/or even prejudiced information about spread-betting. (iv) they are safer and better regulated (by the FSA, a real watchdog with active involvement and real teeth). My own view as a part-time forex trader is that spread-betting definitely has the edge.

If you don't use spread-betting and choose forex trading at a traditional broker such as Oanda, FXCM or Refco, you then have a choice. You can either declare yourself as a "professional speculator" and pay income-tax on your profits, or not. This option may not be as terrible as it sounds, because it's pretty easy to claim/off-set lots of things against income-tax. But that depends on whether you have a job as well, of course. (The reality is that very few people do this). If you don't want to/can't do that either, then you will have to pay CGT (Capital Gains Tax) on profits (this is what almost everyone does who does not use spread-betting). You get a certain amount a year as a tax-free allowance. Unlike income-tax, it's very much harder to claim things against CGT, but this is where a suitably experienced accountant will be able to advise you further.

And not only because of the tax position. Spread betting is simply perfect for swing trading. It is not however suitable for intraday trading, since the house controls the spreads, not the market participants... if scalping, the spread can make an adverse move at precisely the wrong time. The charts dominate currency trading. If you get involved, make sure you get to gripe with the principles of technical analysis.

There are a quite a few people that make decent money spread betting and they are not as stupid as people think they are. So........I say, keep it very, very simple, don't fill your head with pretence or snobbery and if you DON'T feel a bit of trepidation when you are about to trade. Stop right there and walk away. Spreadbetting is as profitable as any other method if it suits you.

The size of the spreads very much depends on the company one chooses and they are not as wide as one is led to believe. Those that argue otherwise have not checked these facts properly and might be surprised at what they find eg. IG Index's option quotes are only slightly wider than those available on LIFFE and move relative to those quotes.

There is always the house edge but if you can find a way of neutralising the house edge, spread betting can offer a convenient, tax efficient means of trading, particularly from limited capital at the start of a longer term plan. Now that competition among spreadbetting firms is increasing some of them have realised that making and keeping it trader-friendly is the way forward and its improving all the time.

Comparing Forex Trading versus Spread Betting -> The Facts

# An advantage of forex brokers is the platform flexibility. A key advantage with dealing with a forex broker is the functionality of being able to place contingent orders (which we are led to believe will soon be available on some spread betting firms)

# Dedicated FX services offer you all the tools in one place, essential in such a volatile market; all the news and research you need is focused on the FX market so it may pay to open accounts with forex brokers just to have access to their advanced trading applications.

# Spread betting also offers the spread better increased leverage. Leverage is a great thing if you know what you are doing - but it is perilous if you don't have a clue. Few people care to admit to themselves that they don't know what they are doing.

# There is one hidden charge most FX brokerage firm fail and avoid to mention. How many forex traders get victimized by interest charges by holding Forex trades more than one day? When I traded Forex, I held a position in GBP-USD from Wednesday to Friday and it cost me an additional interest charge of over $100.00. The majority of forex spreadbetting nowadays takes place on "rolling" products, which have no expiry and no daily charge for keeping the position open.

# When you look at the business models of these sorts of companies, they are essentially the same when it comes to forex. In terms of spread/ bias etc, there is no real noticeable difference between the more reputable forex brokers/ spread betting companies. i.e. both make their own market, both base their prices on the spot interbank market.

# Another hot argument is whether spread betting companies do or don't lay off their bets. They probably do. To be brutally honest though, I really don't give a tinkers cuss whether they do or don't. I'm only interested in my PnL, not theirs!

# If you want to trade directly into the spot market, you need a lot of capital (don't ask how much, I just know I am nowhere near)! Other than futures, retail traders really only have two choices. FX broker or spread betting company.

# Some of the old-fashioned traders have been slow to learn some of the advantages but are making the move as and when they realise that the spread on the FTSE-100 is 2 points rather than 6 as they've wrongly imagined for so long. Many, many people have expensive and extensive losing experience of spreadbetting, usually because they've over-traded, used inappropriate position-sizing, and/or treated it like a form of gambling rather than as a serious business. Understandably, this sometimes makes them very blinkered and prejudiced.

# There is a hot debate going on whether gains from spread betting will or will not remain tax-free if they are one's main source of income. In case anyone's lost among all the words and argument here, let's just state a couple of things openly, simply and clearly here:

(i) no UK resident has ever yet been assessed for income tax or any other form of tax on any spreadbetting profits.

(ii) the Inland Revenue has never announced, indicated or threatened any action or intention to try to tax any UK resident in any way on any profits resulting from spreadbetting.

# Some spread betting firms give you FREE CREDIT, when was the last time HSBC brokers offered you this?

# Some spread betting firms give you FREE CREDIT, when was the last time HSBC brokers offered you this?

# When you trade forex with an ecn broker you regularly experience slippage. This is because they can only pass on trades in blocks of 1 full lot. If they can't pass your trade on due to low liquidity then your trade will experience slippage whether it is your stop/limit order or take profit/stop loss. Now, when you trade with a "stp" (straight through processing) broker who claim to pass your trade on direct to the market you rarely experience slippage unless there is a gap due to a news item, etc.

The interesting thing is that when you start to make money with a stp broker you suddenly find that you are experiencing slippage. Why? This is obviously because once you are flagged as a profitable trader they start to pass your trades on to the market. The same problem occurs as with an ecn broker and they can't pass your trade on immediately all the time as they have to trade in blocks of 1 full lot.

This has happened too many times to be a coincidence and with too many brokers and what it obviously means is that they are NOT passing your trades on "stp" at all unless they consider you a threat to their profits. In this way they are actually behaving exactly as a "market maker" or spread betting company.

How does this relate to spread betting and this article? The big difference that I can see is that the spread betting companies are all pretty much upfront about what's going on. You are betting directly against them but if they don't like the look of you or your bet then they can simply hedge off your trades with the wider market and still make good money on the extra spread you are paying.

# What matters to the successful trader is the overall cost of doing business. The overall cost of doing business is by no means limited to the bid-offer spread of the product dealt in! There are many other factors to take into account. It's naive to pretend otherwise.

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